Is the Hero Worship of Small Startups Misplaced?

It is not that there is anything wrong with small companies, quite the contrary.

But the outsized reputation they enjoy for generating productivity, employment growth and leaping small markets in a single bound may, as the following article explains, be exaggerated. This may result in creating the problems they are thought to solve: wasted effort and misallocation of capital.

In research my colleagues and I have done on IPOs, we learned that the 'typical' IPO does, in fact, have more revenues, employees and has been in existence longer than popular perceptions would suggest. This may be yet another realm in which size doesnt matter.  JL

Giles Wilkes comments in the Financial Times:

Small and new companies are in aggregate less productive. Companies often exist to embody advantages of scale, including “learning economies” that accumulate through time. Too much entry and exit into a market can add up to a lot of wasted effort and capital.
President George W Bush was once believed to have said that the French lack a word for “entrepreneur”. What a pity this is a myth, for in one anecdote it skewered two typically Anglo-Saxon shortcomings — a refusal to master any tongue beyond English, and unthinking infatuation with entrepreneurship.

It is one based on a hazy grasp of its subject. As explained by The Finance Foundation think-tank, “there are numerous, often misleading, definitions of what an entrepreneur actually is”. These lead to misconceptions and misguided political interventions.The modern definition is instead someone “who organises, manages and assumes the risks of a business”. Those who launch start-ups are most lauded of all. Following the economist Joseph Schumpeter, these heroes revolutionise the economy, reorganising industries and finding new ways of doing old things. Their activities are vital for job creation, technological breakthrough and dissolution of stale monopolies. Little wonder the praise they receive — and the taxpayer cash showered over start-ups and small enterprise.

Not all the praise is misdirected. Places where it is hard to create a business often stagnate. Many of the greatest companies of recent times started small and grew within a generation to multinational glory, disrupting older industries: think of Google, Amazon, Facebook or Apple.

But misconceptions abound. One of the more stubborn is the linkage between small business and job creation. As Paul Nightingale and Alex Coad have argued in their masterly takedown of entrepreneurial myths, “Muppets and Gazelles”, such boasts are plagued with poor data and survivorship bias.

Companies that die quickly produce less information than those that survive and thrive. The jobs credited to small outfits are sometimes found to have been created in plants owned by larger companies.
Another persistent myth is the link between new companies and productivity. In theory, start-ups arise to exploit a better way of operating that is currently ignored or suppressed by established businesses.
But the likes of Amazon or Ryanair are the exceptions that prove the rule — that small and new companies are in aggregate less productive. This should not be surprising: companies often exist to embody advantages of scale, including “learning economies” that accumulate through time. Too much entry and exit into a market can add up to a lot of wasted effort and capital.
Such observations lead to a recent theme: the dismal performance of UK productivity, despite startlingly strong business creation. Steven Toft, better known to his fans as Flip Chart Rick, blogs extensively on the topic, and draws attention to a Nesta study that credits existing companies with generating 90 per cent of Britain's pre-crisis productivity growth. A high level of start-up activity may be best explained by managers finding it a useful way to employ cheap but unproductive labour. Worse, a report by the Social Market Foundation found Britain suffers from a dearth of “high-value entrepreneurs” — those likely to hire many more staff. Far from incubating a budding Steve Jobs or Sam Walton, many new businesses are providing work only for the owner.

None of this argues for ignoring small business. Policy makers should strive to “think small first”; larger outfits can manage regulation that ties smaller companies in knots. But rules designed to favour the small also run the risk of persuading businesses to remain that way. Exemptions granted to French companies with fewer than 50 staff explained how France accumulated so many with 49.

Small business is a dream political constituency: numerous, dispersed, and publicly associated with virtues of homeliness, thrift and endeavour. As ever the truth is messier.

Entrepreneurs who can transform the economy are found in companies of any size. The country with the lowest proportion of its workforce in companies with fewer than 50 staff is the US. At the other end of the scale is Greece, then Italy, Portugal and Spain.